🥳 In 2024, will you be a passive or active investor?

Happy new year to you all! I hope most of you were able to take some time off to relax, spend time with friends and family, and maybe even catch up on some hobbies like finishing a book or finally finding the 3 hours to watch “Oppenheimer.” However you spent the holidays, there’s no denying 2023 was a tough year for many of us.

Things in tech and startup land continued to be rough as IPOs remained (mostly) elusive as did funding. Not to mention all the macroeconomic as well as domestic and international political issues that felt like falling dominoes.

But, despite all the seeming gloominess of 2023, things turned out much better than they could have.

The soft landing we were all hoping for may actually be happening as we speak; the stock market had a pretty incredible year (all things considered); and in many ways, it felt like a lot of aspects of daily life were finally coming back to normal — traveling came back and so did the summer blockbuster (aka “Barbenheimer”), to name a few trends.

While we’re all eager to see what 2024 has in store for us we obviously all hope things will continue to be up and to the right. And, if you already haven’t done so, it’s a good time to take a look at your investment strategy. This may not change for many — you keep doing what you’re doing! — but if your goals or financial situation have changed, or may change this year, it’s a good time to reevaluate.

One common question I get from clients and others I speak to is about the notion of active vs. passive investing. Now, I want to be clear, passive investing is not the same as generating passive income. Passive income is also something I hear from many as a top goal (so maybe that’s a future newsletter issue). 

But, in this issue, I wanted to discuss the notion of passive investing. What is it…and does it even exist?

Let me break it down.

🏋️ The difference between active and passive investing

Tomes have been written on the differences between “passive” and “active” investing. The general consensus is that “passive” investing in public markets is better. But I don’t believe there is such a thing as “passive” investing. Every investor is active in some way. It’s not about active vs passive, it’s about how you are active. And as with most things, the devil is in the details. 

Let’s start by laying the groundwork: A passive investor is one who owns the market as a whole and doesn’t overweight or underweight any company, sector, country, etc. A passive investor owns every investment in its proportional weight.

🤔 So, am I a passive investor if I have index funds?

Some investors conflate index funds with “passive investing.” An index fund may be passive in that it follows a rulebook in determining what to own and when to trade. But a portfolio of index funds will almost never truly represent the market with no biases.

Not to mention the fact that index funds are often used to jump in and out of markets in an attempt to time the dips and rallies. So that’s just using index funds to be an “active” market timing investor. Plus, those rulebooks that indexes follow are determined by human beings making active choices about what to include or exclude.

Admittedly, some index funds come closer to others in representing the market as a whole, but in my experience, most folks with portfolios of index funds are not even close to proportional market ownership because they own a hodgepodge of index funds resulting in unintentional directional bets on corners of the market.

Furthermore, some index funds deviate from proportional ownership of stocks/bonds purposefully in pursuit of some theme or strategy they hope will lead to outperformance.

Just because you own an index fund does not mean you are a “passive” investor. It’s likely you are unconsciously making very active choices about your portfolio.

🤨 But it is passive to just dump cash into the S&P 500, right?

What may have already crossed your mind is the FIRE advice to park your cash in the S&P 500, sit back, and reap the benefits (as an example). Many people own an S&P 500 index fund in their portfolios. But, if you disproportionately own the S&P 500, you are an active investor. 

You’re making an implicit bet on the relative performance of the 500 companies in that index. There are over 3,000 companies listed on public stock exchanges in the United States alone and over 10,000 globally. If you combine the S&P 500 Index with the S&P Mid Cap 400 Index and the S&P SmallCap 600 Index, you’re still missing more than 1,000 companies from your US portfolio. That might be fine, but it’s not passive.

🪧 Know what you own

There’s a saying in the investing world, “know what you own.” Do you? A portfolio overweight the S&P 500 Index the last year would have done very well!

US stocks, especially large cap growth stocks like those that dominate the S&P 500, outperformed non-US stocks by several percentage points, but that’s not always the case. Since the year 2000, emerging markets stocks have outperformed the S&P 500 by as much as 35% in rolling 12-month periods (Source: MSCI and Ibbotson data. Emerging markets stocks represented by the MSCI World ex USA Index (net div.); Best relative performance of emerging markets stocks in a 12 month period began 12/31/2012.).

Will the S&P 500 keep winning against the rest of the world next year? I don’t know, but if you’re overweight the S&P 500, that’s the implicit bet you’re making.

🤸 Stay active this year

Further complicating matters is the fact that some investors should want to be active (i.e. deviate from proportional weighting)! For example, if you are employed in the tech sector, and own stock in your private employer, it makes a lot of sense to underweight companies in your public market portfolio with similar characteristics because you already have plenty of exposure to the economic forces and market themes that will drive the success of your employer and your career.

Investment strategies are kind of like Taco Bell food in that, it’s all the same ingredients! There are only so many stocks, bonds, etc. in the world. The passive portfolio is the proportional ownership of all of them and any portfolio is a combination of these investable assets. Understanding how to combine them efficiently and what underlying factors you are exposed to is how you build a “good” portfolio. Know what you own.

Things we’re digging:

• 🌊 Will the liquidity dam break in 2024? Well, we all certainly hope so. Nobody, including me, can predict the future but pressure is building and there have been signs of hope. Canva is just the latest of, mainly, late-stagers to conduct a tender offer (OpenAI is an early-stage outlier) due to the lack of IPOs and M&As. Fingers crossed the pressure keeps building.
• 🍎 Apple takes a fall. The first major stock news of the year is Apple’s tumble due to an analyst downgrade, which, arguably, dragged the market down with it. This take that it’s lack of product innovation isn’t helping is interesting but as I’ve said before — analysts aren’t fortune tellers.
• ⏳ Time travel still isn’t possible. Just ask the folks that were hoping to ring in the new year twice in two different time zones, only to be felled by a delayed flight.